This Undervalued Pharma Is Ready To Move Higher

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, AstraZeneca (NYSE: AZN), together with Bristol-Myers Squibb (NYSE: BMY) announced that the European Commission has approved Forxiga (dapagliflozin) tablets for the treatment of type 2 diabetes in the European Union (EU). Forxiga is a selective and reversible inhibitor of sodium-glucose cotransporter 2 (SGLT2) that works independently of insulin and a represents a unique mode of action compared to other currently available treatments for type 2 diabetes. Forxiga was discovered by Bristol-Myers Squibb and is the latest product to be approved under the collaboration between Bristol-Myers Squibb and AstraZeneca for select investigational drugs for type 2 diabetes. At the end of 2011, diabetes was estimated to affect nearly 53 million people between the ages of 20 to 79 in Europe, and this figure is projected to rise to more than 64 million by 2030.

For the third quarter of 2012, AstraZeneca reported revenues down 15% at constant exchange rates (CER) and gone by 19% on an actual basis as a result of adverse exchange rate movements. Loss of exclusivity on several key brands (including Seroquel IR from the end of March) accounted for most of the revenue decline while disposals of Astra Tech and Aptium accounted for just under 2%. U.S. revenues were down 19% in the quarter, as a result of the loss of exclusivity for Seroquel IR. Excluding Seroquel IR, revenue in the rest of the portfolio increased by almost 6%, including $44 million in new revenue from recognition of the company’s share of the Amylin diabetes portfolio from August 9.

Revenue in the Rest of World (ROW) was down 12% in the quarter. Revenue in Western Europe declined by 20% Loss of exclusivity on four products (Seroquel IR, Atacand, Nexium and Merrem) made up 70 percent of the revenue decline. Emerging Markets was up 6% with increases of 23% in both China and in Russia.  There was modest growth in Brazil and a weak performance in Mexico because of challenging market conditions continues to negatively impact growth.

AstraZeneca’s core gross profit in the third quarter declined by 15%, in line with the decline in revenue. Core gross margin as a percentage of revenue was 81.1%, 10% lower year on year. An unfavorable product mix and higher royalties as a percentage of revenue were broadly offset by benefits from the absence of Astra Tech and lower net expense.  Expenditures in Core SG&A were 12 percent lower than the same quarter of the previous year because of cost management, benefits from restructuring and the absence of Astra Tech costs.  These were partially offset by new sales and marketing spend associated with the Amylin diabetes portfolio. Core other income increased by 103% in the third quarter to $416 million, including $250 million from the agreement with Pfizer (PFE) for OTC rights for Nexium. Core Pre-R&D operating profit was down 11% to $3.72 billion and Core Pre-R&D operating margin was 55.7% of revenue, 2.2% higher than the same period of the previous year. Core operating profit in the quarter was down 14% to $2.632 billion, broadly in line with the decline in revenue.  Core earnings per share were down 8% to $1.51, a smaller decline than Core operating profit as a result of the reduction in the number of shares outstanding because of share repurchases Reported operating profit in the quarter was down 27% to $2.156 billion and reported EPS was down 50% to $1.22.

AstraZeneca has had its own patent cliff problems just like the other major pharmaceutical companies.  The company will lose exclusivity on half its existing patent over the next five years and the company has not yet ventured into generic drugs or other and diversified healthcare products. It is very important to understand the investment risk associated with healthcare companies like these. Failure to meet development targets can be negative because the development of any pharmaceutical product candidate is complex, risky and lengthy involving the commitment of enormous resources.  Negative drug test results tend to depress the share price.  Delayed product launches are equally harmful because they tend to delay the generation of revenues.  Finally countries are increasingly resorting to price controls in an effort to control spiraling health care costs.

Among its peers, Bristol-Myers Squibb produces a dividend yield around 4%. It has an impressive 5-year EPS growth rate of more than 28%. With a price/book ratio of around 3.5, the company looks fairly valued at this point in time. GlaxoSmithKline (NYSE: GSK) has an attractive dividend yield of around 5% but looks slightly pricey because of its price/book ratio of around 8.75 per. GlaxoSmithKline is fancied by investors because of the breadth of its product portfolio which means that it is not entirely dependent on its pharmaceutical business. Johnson & Johnson (JNJ) is a strong, diversified pharmaceutical, medical device, and consumer products company which is seeing solid quarterly revenue growth of 6.5%. It is a rock solid dividend payer but extremely strong financials. Novo Nordisk (NYSE: NVO) recently announced encouraging data from the post-hoc analysis of two phase III b studies on Victoza (liraglutide) in patients suffering from type II diabetes. The performance of Victoza in the U.S. and Europe since launch has been encouraging, and revenues were up 74% year over year in the first nine months of 2012. Sanofi (NYSE: SNY) has been reiterated by TheStreet Ratings as a buy because of its revenue growth, stock price performance and expanding profit margins. Sanofi's revenue growth was higher than the industry average of 3.8% at over 16% and future growth prospects continue to look encouraging.

AstraZeneca is a strong company with a dividend yield of over 6% and a 5-year EPS growth rate of over 13% percent and would be an extremely attractive income investment in its own right. However, the low price to book ratio suggests that this stock is cheap based on valuation and there may be room for capital appreciation. 

jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of AstraZeneca plc (ADR) and GlaxoSmithKline. Motley Fool newsletter services recommend GlaxoSmithKline. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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